A while back, I posted semi-annual results and mentioned that one of the biggest detractors to performance had been busted arbitrage type plays. Today, I want to talk about one of them.

But, before I do, an upfront note. While I think the company represents one of the more interesting situations out there, I’ve also sold out of the vast majority of my position at a pretty darn big loss, so my thoughts are awfully tainted on this one.

To start, some background: First Bank of Delaware was spun off from Republic First Bank (FRBK) at the beginning of 2005. The bounced around from business plan to business plan but were actually quite successful, growing shareholders equity from $14.3m at the end of 2005 to over $46m and book value per share from under $2 to over $4.

However, the company engaged in some products that the FDIC weren’t exactly fans of, and the FDIC required them to shut down the line of business they didn’t like and figure out a new strategic plan going forward (PS: I’m sure many of you are searching for their filings at this point; you can find them all here).

So that’s where I started following them. Honestly, I didn’t wat to invest in them while they were looking for strategic options, as they’d be operating at a loss while trying to figure something out. But an investor I knew and respected continued to think they were interesting, so I kept an eye on them. They were trading at a huge discount to book value, and they did have a big deposit base that a potential acquirer could find interesting.

Book value was around $4 per share (just under $45m in total), the transaction looked like it would result in a small write off of $2m or so total. Add in $5m for liquidation cost, $3m in severance, and $2m in other various cost, and you’d come out with a final liquidation of $35m, or over $3 per share. Even if you thought they would lose half a million or so per quarter until the transaction closed (expected to close early 4th quarter), you were looking at liquidation value of $3 per share in about six months. And that seemed awfully conservative- it was pretty easy to picture a $3.30-3.50 distribution.

So with shares at $2.50-2.60, I bought a pretty decent amount.

And from there, everything started to go wrong. Literally the day after I started buying, bad news started leaking out.

The two were certainly related- the big loss was caused by a huge jump in legal fees.

But the 10-Q not only disclosed cash burn way higher than I had though possible, it also disclosed this gem.

Obviously, when the suit was disclosed, I knew there was going to be some form of damages. But this number seems outstandingly high to me.

As a reader pointed out to me, the company is being sued under FIRREA. Per the FDIC website, the maximum FIRREA fine is $1m, or $5m for repeat offenders. Thus, the $15-20m offer from the government is either 1) ridiculous or 2) a bargaining ploy.

Of course, from the 10-K, it looks like the discontinued businesses earned $7.4m in 2010 and $4.2m in 2011, so maybe the $15m number isn’t outrageous.

So that all brings us up to today.

I still think the company is interesting. At today’s price of $1.56, they’re selling for way under half of book. You know they intend to liquidate as soon as they possibly can, and (unlike a lot of companies trading under book) there’s really no question the assets are worth roughly book, as they’re already got an agreement to sell almost all of their assets.

So an investment really comes down to what you think happens with the litigation.

If they can settle it quickly and for under $5m, you’re probably looking at getting closer to $3 than $2 in distributions.

But if the state/FDIC gets vindictive and the case starts dragging on, legal fees are going to eat into that recovery really heavily. It doesn’t take the case dragging on too long to get the recovery closer and closer to $1.

Given all those risks, why do I mention the stock at all?

Quite honestly, it’s not just to fess up to a mistake. And I’m not as bearish as this article portrays (the bearishness is more caused by the huge capital losses I incurred!). In fact, I think there is a very good chance that the ultimate recovery comes in higher than today’s price. For an investor willing to do some work, I think they could find this a very interesting play for a piece of their portfolio. Again, I think it’s one of the more interesting opportunities out there.

But I have sold a good piece of my position.

Disclosure: Long FBOD, though I did sell a good piece of my position yesterday.

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